Tuesday, June 9, 2009

The Oil Price Oscillator

Most Americans have noticed gasoline prices have been jacked up for the summer driving season. Those who read the financial pages know there is a glut of oil and gasoline available. If the corporations that set pricing keep prices up, and demand remains low, the glut will still be there in September.

But if there is an economic recovery, either in the U.S. or globally, the current glut will work down to normal levels and then to shortages. Prices will get jacked up further at the pump. And that, in turn, should moderate any economic upswing. It might even bring consumer consumption of everything but gasoline crashing back down.

It is very possible that we are in a period of oil prices being the primary oscillator for the economy. That is, when oil prices are up, the economy will slow, stall, and then decline. Oil prices will then fall by a greater percentage than the economy as a whole. Which only allows the economy to repeat the cycle.

This is a limits-to-growth scenario. It assumes the economy can only grow so much without more oil as an input, because the price of oil determines how much of the economic pie is left for everything else.

Over time, oil prices should become less of a controlling factor. We have already seen some of this. The shift from low mile-per-gallon SUVs to smaller cars and hybrids is just one example of how the shift could take place in the long run.

Some economists and analysts will get out their spread sheets and try to make numeric predictions about exactly how oil and gasoline prices will affect the economy in the short run. When dealing with something as complex as the economy, using a rule of thumb is more honest than pretending you can predict with finer granularity. There are too many other factors affecting the macroeconomy, ranging from how the Federal Reserve sets interest rates to billions of one time decisions by individuals that are small in themselves but in aggregate create macroeconomic trends.